The false promise of stablecoins: the next time bomb for the US financial crisis

Article by: Rana Foroohar

Translated by: Block Unicorn

Last week, I was heartbroken when I read that JPMorgan Chase was considering lending against clients' cryptocurrency holdings, even though we all knew the day would come when cryptocurrencies would enter the real economy.

Bitcoin, one of the digital assets banks might use as collateral, has been nearly four times more volatile than major indices since 2020. It's also been linked to terrorist financing, and I haven't read anything that would convince me it's more than a tool for speculators and criminals. But when it's backed by the biggest political donors, that hardly matters.

Over the past few years, cryptocurrency political action committees have spent tens of millions of dollars, donating not only to Republican politicians but also to many Democrats. This effort culminated a few weeks ago with the passage of the Genius Act. Legislation covering other crypto assets is expected later this year. I predict this will not only lead to the next financial crisis but also further fuel populism and political instability in the United States.

All this is reminiscent of 2000, when over-the-counter derivatives advocates flocked to Washington, D.C., pleading for proper "regulation" so they could bring financial "innovation" to the world. Instead, the credit default swap market grew sevenfold, underregulated, ultimately leading to the 2008 financial crisis.

Now consider that U.S. Treasury Secretary Scott Bessant predicts the stablecoin market will grow tenfold in the coming years, from a nearly $200 billion industry to $2 trillion, permeating everything from loan underwriting to the Treasury market.

As Elizabeth Warren, the ranking Democrat on the Senate Banking Committee, told me last week, "We've seen this movie before," with lobbyists "saying 'please regulate us' because they want the government's golden stamp of approval that they are a 'safe' investment," while politicians offer bipartisan support for deregulation.

In fact, you can clearly trace the evolution from derivatives deregulation in 2000, and the broader deregulation during the Clinton era that weakened the barriers between trading and lending, to the 2018 weakening of Dodd-Frank regulations for regional banks (which precipitated the 2023 banking crisis), and now to the Genius Act. It's all been a bipartisan effort.

Warren, elected by voters feeling betrayed by mainstream politicians, tried unsuccessfully to persuade Democrats to reject Republican support for the Genius Act.

But money talks, and the cryptocurrency lobby has demonstrated significant influence by spending $40 million to defeat critics like Sherrod Brown, the former chairman of the Senate Banking Committee in Ohio. Although nearly two-thirds of Senate Democrats voted against the Genius Act, supporters—including influential Democratic senators like Mark Warner of Virginia and Kirsten Gillibrand of New York—were enough to get it passed.

This gives me four reasons to be concerned.

First, the Genius Act (like the Commodity Futures Modernization Act of 2000) is being promoted as a way to make cryptocurrencies safer, with stablecoins backed one-to-one by the US dollar.

But this won't make an overall volatile asset class less volatile. In fact, it may just make the overall market more volatile. Advocates talk about cryptocurrencies like Bitcoin as a hedge against traditional markets, but the reality is that Bitcoin is a "high-beta" investment, meaning it's highly correlated with the stock market. This means both gains and losses relative to the S&P are magnified. Any beta above one indicates higher volatility than the market. A recent Fidelity report found that Bitcoin's three-year rolling beta is 2.6.

Second, I believe the timing for encouraging financial "innovation" couldn't be worse, given such uncertainty about markets, the economy, and monetary policy.

Imagine if, in the coming months or years, the Federal Reserve is forced to raise interest rates sharply due to inflation. Markets would plummet, as they always do when interest rates rise. Cryptocurrencies would fall even deeper and faster. Financial institutions holding cryptocurrencies (including many shadow banks) could run into trouble, causing credit markets to freeze.

Suddenly, we're seeing flashes of 2008. This brings us to my third concern. Supporters of the Genius Act claim it will support the dollar and the Treasury market. But it's easy to imagine cryptocurrency companies like Tether (which holds more Treasuries than Germany) forced to sell Treasuries in a down market to cover redemption losses, seeking safety. Then you'd see Treasury bonds sold off, borrowing costs rising, and another disastrous scenario, with ordinary people under pressure to bail out speculators.

But this time, it happens after growing political skepticism more than two decades ago. Which brings me to my final concern. The financial deregulation pushed by the Clinton administration in the late 1990s laid the groundwork for the 2008 financial crisis and the Democratic Party's loss of support among working people. This, in turn, paved the way for Trump's rise.

Trump is now setting the stage for our next financial crisis by endorsing (and, of course, trading) cryptocurrencies. What happens when we're in financial chaos, voters are increasingly skeptical of mainstream politics, and the government's appetite and ability to mitigate a recession are waning? No cryptocurrencies, no stability.